Right tax policies can stimulate job creation

Close on the heels of a groundbreaking wage deal concluded between the Cosatu-affiliated SA Clothing and Textile Workers Union (Sactwu) and employers in the industry, markedly lowering entry-level remuneration, a new report by the Organisation for Economic Cooperation and Development (OECD) says tax reforms can also help to create jobs. The report recommends especially the lowering of entry-level and low-skilled labour costs.

Throughout most of the world high unemployment rates, in the wake of the 2008 and the presently developing financial and economic crisis, have governments scrambling to create jobs. The number of long-term unemployed is increasing, with young people and low-skilled workers particularly hard hit.

In many countries of both the developed world and emerging economies employment levels among especially the youth have fallen to such low levels that it has become a serious threat to social stability.

In a statement accompanying the release of their report Tax Policy Study No. 21: Taxation and Employment the OECD say G20 Labour and Employment Ministers emphasise that policies to enhance employment are key to the recovery from the financial and economic crisis. The new report “suggests that well-targeted tax reforms can encourage employers to hire more people and the jobless to look for employment”.

As is the case with the Sactwu/clothing industry-deal the OECD-report’s recommendations are aimed at lowering the cost of labour, especially for  targeted groups, as a way of encouraging job creation.

“Taxing employers, through social security contributions or payroll taxes, discourages them from hiring. And taxing employees’ wages lowers their take-home pay and discourages work.

‘Making across-the-board reductions to these tax burdens will be difficult for governments already battling to reduce their deficits. Instead, the report recommends target reforms to generate the greatest employment gains at the most efficient cost.

“In addition to getting more people into work, these reforms will reduce dependency on benefit payments and pension incomes. In light of rapidly ageing populations, this is critical to ensuring the sustainability of social security systems around the world,” the statement reads.

The study suggests that governments should consider tax cuts for employers who hire low-skilled workers – particularly youth and the long-term unemployed. “By lowering the cost of hiring these workers, tax cuts can reduce unemployment among the groups hardest hit by the crisis”, said Jeffrey Owens, director of OECD’s Centre for Tax Policy and Administration.

To give all people an incentive to work, the report proposes a number of reforms targeted at three groups that tend to be under-represented in labour markets across the world: low-income workers; second earners (generally women); older workers. Analysis suggests tax reform would improve incentives and encourage them to work.

In what could be interpreted as an indication that the Sactwu-deal is on the right track and could be trend-setting if supported by appropriate tax-policies, the report states: “While labour taxes will, in general, reduce the level of employment in (the formal sector of) an economy, whether they affect (involuntary) unemployment is slightly less clear. Nevertheless, the weight of both theoretical and empirical evidence tends to suggest that labour taxes may interact with other labour market institutions – such as unionised bargaining and minimum wage laws – to push wages above market clearing levels, thereby increasing long-run “equilibrium” unemployment.

“In particular, strong but decentralizsed (i.e. sectorial) unions may push for higher wages to compensate for a tax increase without fully accounting for any unemployment that may result.

“Meanwhile, generous minimum wage laws in combination with substantial payroll taxes and/or employer social security contributions may price some low-skilled workers out of employment.”

Sactwu general secretary Andries Kriel said it is estimated that the deal “would create 5 000 jobs by March 2014. If this is not achieved, then the agreement will fall away.”

There seems to have been some immediate success, with Cape Town-based manufacturer Peter Blond & Associates announcing that it will increase its workforce by 25% in response to the agreement.

The South African Chamber of Commerce and Industry in its reaction said the deal can serve as a model to other industries to increase SA’s competitiveness and employment creation.

OECD-recommendations

Drawing together the analysis of their report, the OECD states that a number of key employment-related tax policy challenges can be identified. These arise, in general, where high tax burdens are imposed on groups whose labour supply is relatively responsive to economic incentives and provide significant scope for tax reforms to increase employment.

The areas of concern with potential reform options drawn from some country examples discussed in the report include:

• Low-income workers. Effective tax burdens on low-income workers are often very high due to the combined impact of taxation and benefit withdrawal. Empirical evidence also highlights the high responsiveness of low-income workers to these disincentives. Possible options to improve work incentives include: reducing personal income tax and social security contribution burdens on low income workers (e.g. by raising personal allowances), and introducing in-work tax credits (or equivalent benefit schemes). However, the fiscal costs of such tax reliefs and credits limit their affordability; and often lead governments to impose high marginal effective tax rates as credits are withdrawn as income rises (or to provide less generous credits or benefits).
• Older workers. Tax and pension systems often combine to create significant incentives for older workers to retire and empirical evidence suggess that the retirement decision of older workers is highly responsive to such incentives. Where work disincentives are extremely strong, they tend to be driven by pension systems – in which case pension reforms will be the most appropriate means of addressing the problem. In many countries there is substantial scope for tax reform to improve work incentives for older workers. Possible options to improve work incentives include: providing age-based rather than pension-specific tax concessions; reducing social security contribution burdens on older workers to match those due on pension income; and providing in-work tax credits targeted at older workers.
• Mobile high-skilled workers. Tax systems often impose high tax burdens on high-skilled workers, and estimates of taxable income elasticities suggest that high income recipients are more responsive than most taxpayers to tax rates. Limited available empirical evidence does not suggest migration decisions are highly responsive to tax. Nevertheless, international mobility may still be a concern for governments as high-skilled workers can add significant value to an economy. As such, there may be merit, in certain cases, in introducing tax concessions targeted at mobile high-skilled workers.
• Second earners. Tax systems often create significant work disincentives for second earners, while empirical evidence highlights the higher responsiveness of second-earners to these disincentives. Possible options to improve second-earner work incentives include: moving from family-based towards individual-based taxation; increasing individual allowances; and removing dependent spouse allowances.
• Pricing low-skilled workers out of employment. As well as reducing the supply of low-income workers, the high taxes imposed on low-income workers in many countries may also reduce labour demand. This may cause some low-skilled workers to be “priced out” of employment by high employer social-security contributions, generous minimum wage laws, or a combination of both. Possible options to improve demand for low-skilled workers include: reducing employer social-security contributions and providing employer tax credits targeted at low-skilled workers.